Five dumb questions about blockchain and Web3 (which actually aren't dumb at all)

Barnaby Britton, Senior Editor, Blokhaus Inc.

1: What’s the difference between blockchain, cryptocurrency, and Web3?

All three things are connected, but it makes sense to talk about cryptocurrency first. While the idea of ‘electronic money’ has been around for a long time, it was only after the banking crisis and global recession of 2007-8 that the idea of an alternative, fairer, and more secure, financial system based on digital currency really took hold. Published in 2008, the Bitcoin White Paper described a decentralized ‘Peer-to-Peer Electronic Cash System’ that could actually replace fiat currency (state issued money like US dollars or Euros, etc.) at scale, and without the involvement of big tech companies, governments or traditional financial institutions.

In such a system, a record of coin ownership and transactions between parties is kept on a distributed digital ledger (known as a blockchain, which we’ll get to in a minute). The integrity of the ledger is secured using cryptography (more on that in a minute too), so that transactions between users anywhere in the world can happen safely, without intermediaries, and without either party being required to trust or even know the other. Bitcoin went live in January 2009, and it remains the most valuable cryptocurrency at the time of writing, with a market capitalization of $542.7B.

Next – blockchain. You can’t have a cryptocurrency without a blockchain. A blockchain is a read/write-only digital ledger, to which ‘blocks’ of data can be added, but not edited or deleted - hence ‘chain’. The term ‘ledger’ comes from traditional finance, and describes a record of financial transactions - money in, money out, where it came  from, and where it went.

On a very simple level, a blockchain is a tool for creating trust among total strangers

If you’ve ever set up a spreadsheet to track your personal expenses, then you’ve used a ledger. But unlike a Google sheet or Excel document, a blockchain isn’t stored on a harddrive on your computer or in the cloud. Instead, it’s decentralized, meaning it’s distributed across a huge network of computers, known as nodes. Every node on the blockchain holds an identical copy of the ledger, so that it’s practically impossible to alter the record, delete it, or take it offline.

On a very simple level, a blockchain is a tool for creating trust among total strangers. This is necessary, remember, because we’re trying to replace conventional money, and with it, the need for potentially unreliable intermediaries like banks and governments.

Now to Web3, and this is an easy one. The term ‘Web3’ simply refers to the family of internet technologies related to cryptocurrency and blockchain. Even more broadly, it refers to a version of the Internet where users can control and take ownership over their own data, as distinct from Web1 and Web2, where big tech companies like Amazon, Meta, Google and Microsoft are the gatekeepers. Despite the name, Web3 isn’t envisaged as a replacement for Web2 – practically every Web3 project still has a heavy Web2 component.

2: OK I’m interested in blockchain, but I have no interest in cryptocurrency. Can I have one without the other?

Kinda. We said earlier that you can’t have a cryptocurrency without a blockchain, but it is possible to create a blockchain without a native cryptocurrency. In fact, a small number of such blockchains, such as the open-source Hyperledger Fabric, intended for enterprise use, do exist. But for a public blockchain to work at scale, it needs some kind of cryptocurrency. To understand why, it’s important to remember why cryptocurrency and blockchain were invented in the first place – to provide a safer and more equitable alternative to traditional financial models. In order to do this, all parties have to be sure that the record of transactions is trustworthy.

So a successful blockchain needs two things, and they’re interrelated: It needs to be secure - i.e., the data being added to the chain needs to be accurate, and it needs honest users, who won’t attempt to change or make fraudulent entries to the ledger. Cryptocurrency helps ensure both.

The original public blockchain, Bitcoin, uses a ‘Proof of Work’ mechanism to secure the integrity of the data stored on the chain, whereby users (‘miners’) compete to solve complex computational puzzles (‘work’), in order to win the right to record a block of data to the chain. The first miner to find the solution to the puzzle receives compensation, in the form of Bitcoin’s native token, called – you may have heard of it – Bitcoin (BTC). This incentivizes participation, which keeps the blockchain alive, and it also serves as compensation to miners for the energy costs involved in mining. Originally, back in 2009 the reward was 50 BTC, and currently it’s 6.25 BTC.

In 2023, pretty much all major public blockchains except Bitcoin have either switched to, or were designed from the outset to use, the far more energy-efficient Proof-of-Stake governance mechanism. With Proof-of-Stake, rather than being rewarded for solving puzzles, participants on the chain compete to secure the ledger based on their investment, or stake, in the blockchain.

The more successful and active a chain is, the more valuable its token becomes, and as a side-effect, the more likely it is to be treated as a commodity

The idea of staking, just like mining, is to incentivize honest behavior and keep the ledger secure. Honest participants should be rewarded, and dishonest participants must have something to lose. So the stake has to be worth something. Technically, users could stake a fiat currency like US dollars or Euros, but this would become insanely complicated with international transactions, currency exchanges, and so on, which is precisely the kind of mess that cryptocurrency was invented to avoid. Far easier is for the stake to come in the form of the native cryptocurrency of the chain – ETH for Ethereum, Sol for Solana, XTZ for Tezos, etc.

Regardless of the consensus mechanism used, the more successful and active a chain is, the more valuable its token becomes, and as a side-effect, the more likely it is to be treated as a commodity by crypto investors.

3: What can a blockchain do that a conventional database can’t?

The main advantage of a blockchain over a conventional database is security. There are two aspects to blockchain security; first, data recorded to the blockchain can’t be altered or deleted after the fact, and second, the blockchain itself is decentralized, meaning that there’s no need for the kind of traditional hosting infrastructure that might be vulnerable to things like natural disasters, malicious hacking, and government interference. To understand exactly what makes blockchains so secure, see the answer to question 2, above.

This doesn’t mean that blockchains are useful for everything. For example, it doesn’t really make sense to use a blockchain for any application which requires very large amounts of data to be stored and accessed. Blockchains are speeding up, but for now, the number of transactions per second (TPS) possible on most blockchains is still considerably lower than a Web2 platform like VISA, making it impractical (again, for now) to use blockchains for everyday applications where security isn’t of absolutely paramount concern.

4: Why are there so many blockchains? Are they different? How are they different?

Those are big questions, so let’s narrow things down. There are three main types of blockchain: Public blockchains, which anyone can access; private blockchains, which are exactly what they sound like; and permissioned blockchains, which can be accessed only if the user has permission from an administrator. We’re going to focus on public blockchains, because they’re the ones that most people will have heard of and might come into contact with. We’ll also ignore Bitcoin, since it stands alone among major modern blockchains as being strictly a ‘store of value’ chain, with little utility for other applications.

There are several public blockchains, among the best-known being Ethereum, Solana, Cardano, Polkadot and Tezos, which all share some basic functionality – the most important being support for smart contracts. A smart contract is a program that can run on a blockchain when certain conditions are met. NFT sales, for example, are executed via smart contracts (see question 5, below). Perhaps more than any other functionality, support for smart contracts is what makes a blockchain truly useful as more than just a substrate for digital money.

From an end user’s perspective, the differences between the major chains are fairly esoteric. These include different philosophies around how they’re governed, and varying degrees of decentralization

The proliferation of smart contract blockchains over the past decade is an inevitable consequence both of the ‘land grab’ mentality of developers and VCs exploring a new space, and the relative immaturity of the technology. From an end user’s perspective though, the differences between the major chains are fairly esoteric. These include different philosophies around how they’re governed, and varying degrees of decentralization. Ethereum, for example, is heavily decentralized, whereas Solana is faster but somewhat more centralized. Tezos is particularly popular among digital artists for minting and collecting NFTs, whereas others like Polkadot and Avalanche are more focused on decentralized finance (DeFi) applications. For practically all applications, Ethereum is the biggest chain by some margin, but at the expense (literally) of being costlier to use than smaller competitors.

To cut a long story short, unless you’re getting into Web3 development or NFT minting/collecting, it’s unlikely that you’ll ever be in a position where you have to choose between smart contract blockchains. And with Ethereum’s switch from the Proof-of-Work consensus mechanism to the now ubiquitous and vastly more energy-efficient Proof-of-Stake in 2022, you no longer have to worry about the environmental cost of one chain over another.

5: What are NFTs and why should I care?

NFTs, or non-fungible tokens, are among the most talked-about, and arguably least understood technologies to have emerged in the Web3 space. Like Bitcoin, ETH and XTZ, NFTs are tokens stored on a blockchain.

To understand what makes NFTs different to cryptocurrency, it’s important to understand the difference between things that are fungible and things that are non-fungible. Fungible basically just means ‘interchangeable’. A $20 banknote is fungible, in the sense that while each note is a unique physical object, any $20 note is exchangeable for any other $20 note, and every $20 note is worth exactly the same. Similarly, a single unit of cryptocurrency, i.e., a single Bitcoin, is a fungible token. As you can probably guess, a non-fungible token is one that is unique, and cannot be used interchangeably with another.

Concepts of uniqueness and ownership are essential to any creative economy, because they provide a baseline for value when it comes to trade and exchange

NFTs have a vast number of potential use-cases, but it is the digital art community that has really embraced the concept in the past couple of years. That's because when it comes to digital assets, uniqueness is the holy grail. A physical painting is a unique asset, but a piece of artwork that was created using a computer is inherently reproducible. And re-reproducible. And re-re-reproducible. You get the idea. Traditionally this has meant that despite the time and skill required to create them, digital assets (artwork, digital photographs, virtual trading cards, profile pictures, video game objects like weapons etc.) have been considered less valuable, and less collectible than their physical equivalents. NFTs can solve this problem.

It’s important to understand that an NFT isn’t the digital asset itself, it’s a token stored on a blockchain that proves ownership over that asset. Say the asset is a piece of digital artwork stored as a JPEG. Anyone who can access that JPEG will still be able to copy it, but only the person with the NFT in their wallet can prove that they own it. This might sound like a semantic difference, but the concepts of uniqueness and ownership are essential to any creative economy, because they provide a baseline for value when it comes to trade and exchange. Think about it as the difference between having an ‘art collection’ made up of mass-produced prints versus one made up of their painted originals. The pictures might look the same, but only one of those collections has real value beyond just the aesthetic. NFTs don’t just replicate the traditional experience of buying and selling physical assets in the digital realm, they also unlock a fairer deal for creators. Royalties agreements can be programmed into NFTs, ensuring that – for example – the original creator will always receive a percentage of the price of their piece if and when it’s resold.

Glossary:

• Blockchain
  A decentralized read/write-only ledger that stores a record of transactions. ‘Blocks’ of data are stored in a ‘chain’ which cannot be deleted or altered alfter the fact – only added to.
• Cryptocurrency
  The native token of a blockchain. Tokens are the basic unit of exchange between users of a blockchain and some, like Bitcoin (BTC) and Ethereum (ETH) are treated as investment assets, or ‘stores of value’, by speculators.
• Crypto
  General catch-all term describing anything relating to blockchain and cryptocurrencies. Crypto market, crypto Twitter, crypto bro, etc.
• Web3
  A general catch-all term for the family of Internet technologies that are related to blockchain, including cryptocurrency, NFTs, and the metaverse.
• Consensus mechanism
  The method by which data is secured on a blockchain. Bitcoin uses an energy-intensive ‘Proof-of-Work’ mechanism, whereas almost all other major chains use the more efficient ‘Proof-of-Work’.
• Ledger
  A record of financial information. A blockchain is a digital ledger.
• Fiat currency
  Traditional money, issued by and guaranteed by a sovereign state, i.e., US Dollars, Euros etc.
• NFT
  Non-fungible Token. A token stored on a blockchain that proves ownership over a digital asset.

__

Blokhaus is a marketing and communications agency with a focus on Web3 and emerging tech. Since we were founded in 2021, Blokhaus has supported numerous high-profile projects and activations around the globe, working in partnership with some of the biggest brands in the world. To learn more about our work, check out our Case Studies. To get in touch, visit our Contact Us page.